Generac Holdings Inc. (NYSE:GNRC) Q4 2023 Earnings Call Transcript

Generac Holdings Inc. (NYSE:GNRC) Q4 2023 Earnings Call Transcript February 14, 2024

Generac Holdings Inc. misses on earnings expectations. Reported EPS is $2.07 EPS, expectations were $2.09.

Generac Holdings Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to Generac Holdings Fourth Quarter and Full Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Kris Rosemann, Senior Manager, Corporate Development and Investor Relations. Please go ahead.

Kris Rosemann: Good morning, and welcome to our fourth quarter and full year 2023 earnings call. I’d like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer; and York Ragen, Chief Financial Officer. We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation as well as other information provided from time to time by Generac or its employees may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see our earnings release or SEC filings for a list of words or expressions that identify such statements and the associated risk factors.

In addition, we will make reference to certain non-GAAP measures during today’s call. Additional information regarding these measures, including reconciliation to comparable US GAAP measures, is available in our earnings release and SEC filings. I will now turn the call over to Aaron.

Aaron Jagdfeld: Thanks, Kris. Good morning, everyone, and thank you for joining us today. Happy Valentine’s Day. I think I can say that. Our fourth quarter results reflect continued improvement in operating performance as shipments of home standby generators returned to strong year-over-year growth in the quarter, despite a softer-than-expected power outage environment. We also experienced significant margin expansion in the quarter, driven by favorable mix and price cost tailwinds on both a year-over-year and sequential basis. In addition, we generated record free cash flow in the quarter on the continued reduction of our inventory levels. Year-over-year, overall net sales increased 1% to $1.06 billion, and core sales were approximately flat during the quarter.

Residential product sales increased 1% from the prior year as growth in home standby generator shipments offset lower portable generator sales in the quarter. C&I product sales were approximately in line with the strong prior year fourth quarter, as softness in the domestic telecom and rental channels was offset by continued strength in broader C&I end markets. Before discussing our fourth quarter results in more detail, I want to provide some highlights for the full year 2023. Global C&I product sales in 2023 reached an all-time record of approximately $1.5 billion, our third consecutive year of strong double-digit growth in the category, resulting in a nearly 30% sales, compounded annual sales growth rate over those three years. This included record full year performance in our International segment for both net sales and adjusted EBITDA.

The strength in our C&I products has helped to offset the headwinds in our residential product categories related to elevated levels of home standby generator field inventory in 2023 and a strong comparable period that included the benefit of excess backlog reduction. Although our shipments to the market were impacted by these factors during the year, home consultations or sales leads increased for the full year despite not having the benefit of a major outage event during 2023. Additionally, our return to improving margin performance in the second half of the year, together with the continued reduction in our inventory levels, helped drive cash flow from operations to an all-time record for full year 2023. This robust cash flow generation provided additional flexibility with respect to our capital deployment as we completed $252 million of share repurchases, while also continuing to invest in advancing our products and solutions road maps during the year.

We continue to make significant investments in our engineering and manufacturing capabilities in 2023, as we opened an engineering center of excellence in Reno, Nevada, and broke ground on a new manufacturing facility in Wisconsin to increase capacity for C&I stationary products. We also continue to launch compelling new products during the year, including the introduction of stationary C&I energy storage solutions for the domestic market to help decentralize, digitize and decarbonize the future electrical grid with advanced microgrid applications. In addition, the ecobee team launched a smart doorbell camera product line, helping to drive engagement to their platform. We also made important progress towards our vision of building a common platform and user interface for our suite of residential solutions through the integration of our home standby generators and propane tank monitoring devices using ecobee as the central hub to manage our products and solutions.

Additionally, we introduced our new — it’s a power move advertising campaign to help drive incremental consumer awareness of the home standby generator category to a broader demographic range. We made further strategic investments in 2023 that help to accelerate our powering of Smarter World Enterprise Strategy, as we acquired REFU Storage Systems, a provider of stationary C&I energy storage solutions for European markets and made a minority investment in Wallbox, a leading provider of EV charging solutions for both residential and commercial applications. Our investment in Wallbox is expected to result in global commercial collaboration as well as the addition of a Generac seed on the Wallbox Board of Directors. We’re excited to partner with an innovative technology leader in the EV charging industry and look forward to integrating Wallbox’s solutions with our broader energy technology portfolio to further expand the value proposition of the energy ecosystem that we are building for homes and businesses.

Importantly, throughout 2023, the megatrends that we believe will drive our longer-term growth were on full display as increasingly severe weather, coupled with the continued evolution of the energy grid in the U.S. further demonstrated the important role that our products and solutions can provide to the market. Although, the U.S. did not experience any major power outage events during 2023 and despite the fourth quarter being the lowest fourth quarter for outage hours since 2015, there were numerous smaller scale severe weather events that did occur throughout the year across a number of regions in North America, which drove monthly power outage activity above the long-term average baseline. In addition to the increasingly frequent and higher magnitude weather-related power disruptions, legislative and regulatory reactions to climate change are also impacting the power grid as well.

On the supply side, utility scale, solar and wind power are being incentivized relative to traditional base-load thermal sources, but they are intermittent in nature and continue to face growing siting and permitting challenges. At the same time, demand is increasing as electrification trends are accelerating around heating, cooking and transportation and power-hungry data center and telecom infrastructure continues to rapidly build out. These changes are creating significant challenges as utilities and grid operators are struggling to reliably match supply and demand, particularly during periods of extreme heat during the summer and cold during the winter. In its 2023 long-term reliability assessment, the North American Electric Reliability Corporation, or NERC, continued to warn of the elevated risk of resource shortfalls across the majority of the U.S. and Canada.

As key forecasts around supply availability and future electricity peak demand are creating a higher risk of imbalance, leading to potential outages more so than any time in recent history. As a result of these factors, we expect there will continue to be significant opportunities for our portfolio of power resiliency and energy efficiency solutions well into the future. Specifically for the home standby generator category, we believe a massive penetration opportunity still remains. As only 6.25% of the addressable market of single-family unattached homes greater than $150,000 in value in the U.S. had a home standby generator installed at the end of 2023. Furthermore, every 1% of incremental penetration is worth approximately $3 billion of market value.

And with a market share greater than 70%, we believe Generac is incredibly well positioned to continue to lead the commercialization of this important product category. These same mega trends create significant opportunities for our global C&I products and solutions as businesses are also concerned about navigating power reliability issues and volatile energy prices. Near-term, we are focused on further executing on our strategic vision, which we believe puts Generac in a unique position to help home and business owners solve for the energy-related challenges that lie ahead. Now, discussing our results in more detail. Fourth quarter home standby shipments increased approximately 10% from the prior year despite continued field inventory de-stocking and a softer-than-expected power outage activity, which also weighed on home consultations during the quarter.

However, in early 2024, severe winter storms pushed outage activity to record levels for the month of January. Power conservation notices sent to homeowners in select markets, driven by unseasonably cold temperatures and the related spike in power demand also contributed to consumer awareness of the vulnerability of the electrical grid. As a result of these factors, home consultations in January of this year were an all-time record for the month. Our residential dealer count ended the fourth quarter at approximately 8,700 in line with the prior year count. Dealer productivity trends further improved in the quarter, and we continued to execute on our initiatives to train non-dealer contractors, helping to increase overall installation capacity.

Notably, close rates improved moderately during the fourth quarter, helping to offset the impact of lower power outage activity and softer home consultations. More importantly, activations, which are a proxy for installations, were at an all-time quarterly record in the fourth quarter, increasing slightly from the previous record of the fourth quarter of 2022, providing further support for our belief that the home standby category is holding a new and higher level baseline level of demand. The record activations in the fourth quarter helped to further reduce the number of home standby generators in our distribution channels as we continue to under ship end market demand in the quarter. As certain regions and channels of the home standby market have returned to normal ordering patterns, the gap between shipments and activations further narrowed as we exited 2023, and we continue to expect overall shipments and activations to align later in the first quarter of this year.

For 2024, we expect home standby sales to increase at a rate approximately in line with the mid-teens residential sales growth guidance disclosed in our press release this morning. Additionally, we expect home standby generator sales to increase on a year-over-year basis in each quarter throughout the year, assuming that power outage activity is in line with the historical baseline average. In addition to home standby generator shipments returning to growth, Sales of our residential energy Technology Products and Solutions also increased during the fourth quarter as compared to the prior year, led by continued growth at Ecobee as our team there continued to gain share in the smart thermostat market by driving momentum with professional contractors and further expanding their presence with key retail partners.

The fourth quarter launch of Ecobee smart doorbell camera was well received by consumers and industry experts and continued to showcase their expertise in delivering consistently positive customer experiences. Ecobee finished 2023 with more than 3.5 million connected homes, giving us a large installed base of satisfied customers that we can cross-sell our products and service capabilities to as we work towards rolling out our residential energy technology ecosystem. We experienced another important event during the fourth quarter as we were awarded grants from the Department of Energy to utilize our residential energy technology solutions for resiliency focused programs in Puerto Rico and Massachusetts over the next several years. The program in Puerto Rico is expected to utilize our energy storage systems to provide clean energy independence for residents.

The program in Massachusetts is expected to include our energy storage systems, Ecobee Smart Thermostats and grid services capabilities, demonstrating our ability to integrate multiple technologies to support our home’s energy needs while also providing additional value for grid operators by aggregating and managing these distributed energy resources in a virtual power plant setting. As previously mentioned, we made an important minority investment in Wallbox during the fourth quarter, which provides for a future seat on the Wallbox Board of Directors and creates the opportunity for global commercial collaboration across our residential and C&I distribution networks. The partnership also brings future access to industry-leading bidirectional charging development, which we believe will play an increasingly critical role in our emerging residential energy technology ecosystem as the penetration of electric vehicles increases in the future.

For 2024, we expect gross sales for residential energy technology products and services, including energy storage, energy management devices and services, connectivity and home EV charging solutions to be in a range of $325 million to $350 million, a year-over-year growth rate of approximately 25%. We continue to make meaningful investments in building out our residential energy ecosystem, including our next-generation energy storage system, which is expected to be commercially available later in the second half of this year. I would now like to provide some commentary on our commercial and industrial products. Global C&I product sales were approximately flat on a year-over-year basis in the fourth quarter and increased 19% for the full year 2023, to approximately $1.5 billion.

Domestic C&I product sales declined modestly during the fourth quarter as softness in shipments to the telecom and rental channels offset continued strength in sales to our industrial distributors and other direct customers for beyond standby applications. Shipments of C&I generators through our North American distributor channel again grew at a robust rate in the fourth quarter. Although order patterns in the second half of the year were impacted by extended product time lines, quoting activity remained resilient despite being off the peak levels experienced earlier in 2023. Shipments of natural gas generators used in applications beyond traditional standby projects increased at a very strong rate during the fourth quarter. As the leading provider of natural gas generators, we continue to pioneer new market opportunities for beyond standby generator applications and other energy technology solutions in C&I end markets.

We are working to facilitate the development of our increasingly comprehensive products and solutions in multi-asset applications, such as pairing our smart grid ready natural gas generators with our emerging C&I storage, connectivity, advanced controls and grid services platforms. While we believe this is an important long-term growth opportunity, today’s higher interest rates are putting pressure on project time lines. And as a result, we expect shipments of products for beyond standby related applications to be negatively impacted in 2024. Sales to our national and independent rental equipment customers in the fourth quarter declined from the prior year as order patterns remained weaker than the stronger prior year comparisons. Despite the normal cyclical softness in this vertical that is impacting our overall 2024 expectations, we continue to believe that this end market has substantial runway for growth given the critical need for future infrastructure related projects that leverage our products sold into the rental equipment channels.

As expected, shipments to national telecom customers declined again during the quarter, particularly when compared to the very strong prior year fourth quarter level as these customers further reduced capital expenditures. Given our current visibility, we expect shipments to telecom national accounts will remain soft in the coming quarters, weighing on our overall 2024 outlook. However, we have experienced these CapEx spending cycles over the 40 years we have been serving this market, and we believe the near-term cyclicality will not change the longer-term secular trend of increasing global tower and network hub counts and the increasingly critical nature of wireless communications and related services that are requiring significantly greater power reliability.

Internationally, total sales were pressured by lower inter-segment sales, primarily related to declines in inter-company shipments from our Mexican operations to the domestic telecom market, as well as lower shipments of portable generators in Europe, as energy security concerns resulting from the Russia-Ukraine war continue to abate. Helping to offset this weakness, international net sales in other emerging markets such as India, the Middle East and East Asia grew at a strong rate during the quarter. International growth remains an important strategic focus for us moving forward with significant opportunities and continued geographic expansion and further penetration of underserved markets as we implement the generic playbook across a growing global footprint.

As disclosed in our press release this morning, we expect global C&I product sales to decline by approximately 10% for full year 2024, as weakness in shipments to certain direct telecom, rental and beyond standby customers is expected to more than offset growth in other regions and channels. In closing this morning, we believe our fourth quarter results reflect a return to positive momentum in our overall business as our residential product sales began to grow again, which should help to offset cyclical softness in certain C&I customers and end markets. We believe we are nearing the end of the excess field inventory overhang for home standby generators and expect to realize strong year-over-year growth in shipments of these products in 2024.

This momentum gives us confidence in continuing to focus on building out our longer-term vision for both residential and C&I energy technology ecosystems. Our record cash flow performance in the fourth quarter is continued evidence of the earnings power of our business and gives us flexibility to prioritize further organic investments, execute on strategic acquisitions and opportunistically return capital to shareholders. Most importantly of all, the mega trends that support our longer-term opportunities remain firmly intact and our conviction in our powering a Smarter World enterprise strategy is as strong as ever. I’ll now turn the call over to York to provide further details on our fourth quarter and full year 2023 results and our outlook for 2024.

York?

York Ragen: Thanks, Aaron. Looking at fourth quarter 2023 results in more detail. Net sales increased 1% to $1.06 billion during the fourth quarter of 2023 as compared to $1.05 billion in the prior year fourth quarter. The combination of favorable contributions from acquisitions and foreign currency had an approximate 1% impact on revenue growth during the quarter. Net sales for the full year 2023 decreased 12% to approximately $4.02 billion. The combination of favorable contributions from acquisitions and foreign currency had an approximate 2% impact on revenue during the full year. Briefly looking at consolidated net sales for the fourth quarter by product class. Residential product sales increased 1% to $580 million as compared to $575 million in the prior year.

Growth in residential product sales was driven by a strong 10% increase in shipments of home standby generators and a more modest increase in energy technology products led by Ecobee. This was partially offset by lower portable generator shipments in the US and Europe, given a tough prior year comparison. Commercial and industrial product sales for the fourth quarter of 2023 increased slightly to $363 million as compared to $361 million in the prior year quarter. Contributions from foreign currency and the refuse storage acquisition contributed approximately 3% growth during the quarter. This core sales decline is due to weakness in sales to our domestic telecom and national equipment rental customers, partially offset by an increase in C&I product shipments to industrial distributors and direct customers for beyond standby applications, in addition to strengthening international sales into emerging markets.

Net sales for the other products and services increased approximately 6% to $120 million as compared to $113 million in the fourth quarter of 2022. Core sales growth of 5% was primarily due to growth in our domestic C&I service offerings from our owned industrial distributors, aftermarket service parts, connectivity subscription revenue and ecobee services. Gross profit margin was 36.5% compared to 32.7% in the prior year fourth quarter as a result of favorable sales mix, production efficiencies and lower raw material and logistics costs as supply chain challenges abated relative to the prior year. Operating expenses increased $2 million or 1% as compared to the fourth quarter of 2022. This increase was primarily driven by higher employee and marketing costs.

The current year and prior year quarters also include approximately $11 million and $10 million, respectively, of onetime items that we believe are not indicative of our ongoing operations. See the reconciliation schedules in our earnings release for more information on these items. Adjusted EBITDA before deducting for non-controlling interest, as defined in our earnings release, was $213 million or 20% of net sales in the fourth quarter as compared to $174 million or 16.6% of net sales in the prior year. For the full year 2023, adjusted EBITDA before deducting for non-controlling interest was $638 million or 15.9% of net sales as compared to $825 million or 18.1% in the prior year. I will now briefly discuss financial results for our two reporting segments.

Domestic segment total sales, including intersegment sales, increased 1% to $891 million in the quarter as compared to $881 million in the prior year. Adjusted EBITDA for the segment was $192 million, representing 21.6% of total sales as compared to $144 million in the prior year or 16.4%. For the full year 2023, domestic segment total sales decreased 15% over the prior year to $3.32 billion. Adjusted EBITDA margins for the segment were 15.8% compared to 18.2% in the prior year full year. International segment total sales, including intersegment sales, decreased 13% to $190 million in the quarter as compared to $219 million in the prior year quarter, including an approximate 7% sales growth contribution from foreign currency and acquisitions, resulting in approximately 20% core total sales decline.

Adjusted EBITDA for the segment before deducting for non-controlling interests was $20.4 million or 10.7% of total sales as compared to $29.5 million or 13.5% in the prior year quarter. For the full year of 2023, International segment total sales increased 6% over the prior year to $838 million. Adjusted EBITDA margins for the segment before deducting for non-controlling interests were 13.7% of total sales during 2023 as compared to 13.8% in the prior year full year. Now switching back to our financial performance for the fourth quarter of 2023 on a consolidated basis, as disclosed in our earnings release, GAAP net income for the company in the quarter was $97 million as compared to $71 million for the fourth quarter of 2022. The current year net income includes approximately $5 million of additional interest expense compared to the prior year due to higher borrowings and interest rates.

GAAP income taxes for the current year fourth quarter were $30 million or an effective tax rate of 23.7% as compared to $13.6 million or an effective tax rate of 15.5% for the prior year. The increase in effective tax rate was primarily driven by discrete tax benefits in the prior year quarter that did not repeat in the current year. Diluted net income per share for the company on a GAAP basis was $1.57 in the fourth quarter of 2023 compared to $0.83 in the prior year. The strong year-over-year increase in net earnings per share relative to growth in net income was primarily driven by an unfavorable $18.4 million redeemable non-controlling interest redemption value adjustment that was recorded in the prior year period, as well as a lower share count in the current year period.

Adjusted net income for the company, as defined in our earnings release, was $126 million in the current year quarter or $2.07 per share. This compares to adjusted net income of $113 million in the prior year or $1.78 per share. Cash flow from operations was $317 million as compared to $101 million in the prior year fourth quarter, and free cash flow, as defined in our earnings release, was an all-time quarterly record of $266 million as compared to $80 million in the same quarter last year. The significant improvement in free cash flow was primarily due to a $144 million reduction in inventory during the quarter and higher operating earnings. This was partially offset by higher capital expenditures during the current year quarter. Total debt outstanding at the end of the quarter was $1.58 billion, resulting in a gross debt leverage ratio at the end of the fourth quarter of 2.5 times on an as-reported basis.

Additionally, during the fourth quarter, we repurchased approximately 1.3 million shares of our common stock for approximately $151 million. As disclosed in our press release this morning, the company’s Board of Directors has approved a new stock repurchase program that allows for the repurchase of up to $500 million of our common stock over a 24-month period, replacing the remaining balance on the previous program. For the full year, cash flow from operations was an all-time record of $522 million as compared to $59 million in the prior year. And free cash flow, as defined in our earnings release, was $396 million as compared to minus $24 million in 2022. We strategically deployed approximately $153 million of capital in 2023, with the acquisition of refuse storage systems, the purchase of the remaining 20% minority ownership interest in Pramac and the minority investment in Wallbox.

In addition, capital expenditures totaled $129 million to support additional capacity for future organic growth. We also opportunistically repurchased approximately 2.2 million shares of our common stock for $252 million during the second half of the year. Moving forward, we will continue to operate within our disciplined and balanced capital allocation framework as we accelerate our powering a Smarter World enterprise strategy and execute other shareholder value-enhancing opportunities. With that, I will now provide further comments on our new outlook for 2024. As disclosed in our press release this morning, we’re initiating 2024 net sales guidance that anticipates a return to growth for the full year period. This increase is expected to be led by higher home standby generator sales as shipments are projected to be more closely aligned with activations during 2024.

We also expect our residential energy technology sales to grow as we expand distribution and launch our next-generation energy storage system later in 2024, and we continue to drive strong growth with our Ecobee products and solutions. Overall, we expect residential product sales to grow in the mid-teens range for 2024. However, in our C&I product category, cyclical pressures for certain telecom, rental and beyond standby customers, are expected to be more than offset or expected to more than offset continued growth in broader C&I end markets around the world. As a result, we are projecting global C&I sales to decline by approximately 10% in 2024 compared to the prior year. As a result of these factors, we expect consolidated net sales for the full year to increase between 3% to 7% as compared to the prior year, which includes a slight favorable benefit from foreign currency.

Importantly, this guidance assumes a level of power outage activity during the year in line with the longer term baseline average. Consistent with our historical approach, this outlook does not assume the benefit of a major power outage event during the year, such as a Category 3 or higher landed hurricane or major winter storm, which we believe could add $50 million to $100 million of sales. As a result of this top line outlook, we expect sales to be in line with normal historical seasonality, resulting in overall net sales in the first half being approximately 45% weighted and sales in the second half being approximately 55% weighted. Specifically for the first quarter, we expect overall net sales to be nearly flat from the prior year first quarter, with solid growth in residential product sales offset by a decline in C&I product shipments.

With Q1 2024 being the seasonal low point of the year, we expect sales for each product class to increase sequentially throughout the year. Looking at our gross margin expectations for the full year 2024, we expect the realization of lower input costs and favorable mix impact from higher home standby sales volumes to drive continued year-over-year improvement throughout the year. As a result, we expect gross margins to increase by approximately 300 basis points for the full year as compared to 2023. From a seasonality perspective, we expect gross margins to increase by approximately 350 basis points on a year-over-year basis in the first quarter to approximately 34% to 34.5% due to favorable sales mix impact from higher home standby shipments and realization of lower input costs.

These factors are also expected to result in sequential gross margin improvement into the second half of the year with second half gross margins projected in the 38% range. With respect to operating expenses, we continue to invest heavily in the resources needed to position our business for longer term growth in new and existing markets, maintaining a heavy focus on supporting innovation, and executing our strategic initiatives across the enterprise. As a result of these investments, we expect operating expenses as a percentage of sales to be approximately 23% for the full year 2024. We expect to leverage these costs as we sequentially grow from first half to second half, helping to improve our EBITDA margins throughout the year. As a result of our gross margin and operating expense expectations, adjusted EBITDA margins before deducting for non-controlling interests are expected to be approximately 16.5% to 17.5% for the full year, compared to 15.9% in 2023.

From a seasonality perspective, we expect adjusted EBITDA margins to improve significantly as we move throughout the year. Specifically, regarding the first quarter, adjusted EBITDA margins are expected to be the lowest for the year in the mid-12% range, and then improved sequentially throughout the year, returning to approximately 20% in the fourth quarter. As a result, second half adjusted EBITDA margins are expected to be nearly 600 basis points higher than the first half margins. Additionally, as Aaron discussed, we continue to make significant investments in our residential energy technology products and solutions to capitalize on the opportunities presented by these robust long-term growth markets. As a result, we currently expect residential energy technology to dilute our EBITDA margins by approximately 350 basis points to 400 basis points for the full year 2024, similar to the level of dilution experienced in 2023.

As is our normal practice, we’re also providing additional guidance details to assist with modeling adjusted earnings per share and free cash flow for the full year 2024. Importantly, we arrive at appropriate estimates for adjusted net income and adjusted earnings per share, add back items should be reflected net of tax using our expected effective tax rate. For 2024, our GAAP effective tax rate is expected to be between 25% to 26%, as compared to 25.2% full year GAAP tax rate for 2023. We expect interest expense to be approximately $85 million to $90 million, assuming no additional term loan or revolver principal prepayments during the year, and assuming sulfur rates declined throughout 2024 in line with market expectations. Our capital expenditures are projected to be approximately 3% of our forecasted net sales for the year.

At the high end of our historical range, as we add incremental C&I manufacturing capacity and execute other projects to support future growth expectations. Depreciation expense is forecast to be approximately $70 million to $73 million in 2024, given our assumed CapEx guidance. GAAP intangible amortization expenses in 2024 is expected to be approximately $95 million to $100 million during the year. Stock compensation expense is expected to be between $55 million to $60 million for the year. Operating and free cash flow generation is expected to be disproportionately weighted toward the second half of the year in 2024, similar to 2023. For the full year, we expect free cash flow conversion from adjusted net income to be strong at approximately 100% as we continue to monetize working capital builds of prior years.

Our full year weighted average diluted share count is expected to decrease to approximately 61 million shares, as compared to 62.1 million shares in 2023, which reflects the share repurchases that were completed in the latter half of 2023. Finally, this 2024 outlook does not reflect potential additional acquisitions or share repurchases that could drive incremental shareholder value. This concludes our prepared remarks. At this time, we’d like to open up the call for questions.

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Q&A Session

Operator: Thank you. We’ll conduct the question-and-answer session. [Operator Instructions] Our first question comes from George Gianarikas with Canaccord Genuity. Your line is open.

George Gianarikas: Hi. Good morning and thanks for taking my question.

Aaron Jagdfeld: Hey, George.

George Gianarikas: Would you just maybe focus on the HSB and the residential growth assumed for 2024 and mid-teens. Can you just help us understand what the underlying activation growth is that buttresses that guidance for the year? Thank you.

York Ragen: Yes. George, I mean, we’re not expecting a decline. I mean, obviously, in the current environment with a softer consumer tied to big-ticket discretionary. We didn’t want to take an aggressive assumption on the activation rate assumptions. Obviously, what we said in the prepared remarks, home standby, we expect to grow somewhere in that mid-teens range year-over-year, similar to the overall residential category that we guided that way. Again, a lot of that is the fact that the destock of field inventory in 2023, while some of that is going to continue here in Q1, that will abate here in Q2 and for the rest of the year. So, a good chunk of that year-over-year growth is the fact that we don’t have that that overhang on the field inventory but we aren’t assuming that the home standby market is declining, some modest growth.

Aaron Jagdfeld: It’s kind of holding that new and higher baseline assumption that we talked about. In the absence of kind of power outage activity being above the baseline, we guide with it in line. So, I think in the prepared remarks, we even said we don’t include any assumptions for major outages, and that could include — that could drive additional opportunities, both with home standby and portable generators actually. But the assumption, I think York is right, with in kind of big ticket discretionary items in environment where rates remain somewhat elevated here, we think that consumer demand could remain kind of flattish and kind of at that baseline level.

Operator: Our next question comes from Michael Halloran with Baird. Your line is open.

Michael Halloran: Hey good morning everyone.

Aaron Jagdfeld: Hi Mike.

Michael Halloran: Could you talk about the energy tech side of things, obviously, the 25% growth? Maybe a little better understanding what you could be versus the other products. But more importantly, maybe talk about the expectations for how you’re expecting the new product launches? And I don’t know if rebranding is the right word, but certainly, the newer pieces that you’re going to be bringing to market. How do you expect that to start impacting the revenue line? Obviously, you heard York’s comment on the margin impact year-over-year, the dilution there, but more just kind of a revenue thought process and how you’re thinking about the cadencing of that being launched into the market.

Aaron Jagdfeld: Yes. Thanks Mike. I mean a lot of the new products that we talked about. I mean we’re in development right now and have been for the better part of 2023, actually, because we’re going to make sure we get it right, and these are the products that are going to be at the top of the market, if not market leading, both for the energy storage products, which our next-generation energy storage devices, which should hit the market here later this year kind of as we exit Q3 and get into Q4. So, we really only have a very modest amount of topline allocated to that launch. We think it will get more traction. We have a lot of work to do, obviously, you call it rebranding, building out the distribution, regaining the confidence of the market with those installers in particular.

We’ve been doing a lot of work there, and I think we’re making headway, but we need to get the new products in the market. And so, there’s not a ton of growth on that side. Ecobee, we do see continued growth there. They continue to take share. That has been just a fantastic asset for us, not only in just its growth curve, but also just the technology and the competencies that they bring to us relative to what we’re trying to achieve with the user experience, right? So, we want everything we’re calling it kind of single pane of glass is kind of our reference to it. But putting everything on the same platform, we’ve got — we’ve acquired and/or have a lot of technologies organically that we’ve got products and solutions around, but bringing it all together to work seamlessly and synchronously, that is a lot of work.

And so behind the scenes, as we introduce each new product, so this next-generation storage device, when we get to the micro inverter products, which will hit the market early next year in 2025, those products will all be — they will all operate within the single pane of glass platform. You’ve seen some evidence how we’ve started to weave pieces together already this year. We’ve got home standby generators now visible. If a homeowner has an Ecobee thermostat, you can see the status of your home standby generator. If that generator happens to be running on propane, you can see the status of your propane fuel level, if you have a tank utility monitoring device. So all of these pieces are starting to get woven together and integrated. We’re going to do the same with the Wallbox products as those roll into the market.

So again, building all that out, I think Ecobee has been just a tremendous — they have a great team, very adept at what they do. And on top of the top-notch products that they’re in market with, with the smart thermostats and their doorbell camera, they’re able to help kind of integrate this ecosystem and really bring it to life.

Operator: One moment for our next question. Our next question comes from Jeff Hammond with KeyBanc Capital Markets. Your line is open.

David Tarantino: This is David Tarantino on for Jeff.

Aaron Jagdfeld: Hey, Dave.

David Tarantino: Could you maybe give us a little bit more color on where you see the home standby channel inventories versus the normal levels? It sounds like there’s some lingering destocking into the first quarter. So maybe how much do we have left? And maybe on that, could you give us an update on the $300 million tailwind from the absence of destocking? Do we get all of that this upcoming year?

Aaron Jagdfeld: Yes. Thanks, Dave. So as we said, kind of in line with our expectations, we were getting very close to kind of wiping out that field inventory. We’ll call it an abnormal excess field inventory. Look, this has been a painful process over the last six quarters. We overproduced ahead of the market demand, got ahead of ourselves, and we just — we’ve been working that down. We were very close to — we saw kind of normal order pattern starting to return in Q3 even and into Q4 for sure. And then we believe that most of that is going to be gone as we exit Q1. You’re always going to have pockets markets, channels, customers that have field inventory levels that are probably higher than normal. That has always existed.

If you don’t get an event in a market or you’ve got maybe a channel that’s underperforming to other channels. I mean, you can have that happen, and that’s just normal cadence. So I would say that the big excess field inventory level, that thing we’ve been talking about here for 6 quarters non-stop. We believe, is going to be largely gone by the end of Q1.

York Ragen: We definitely saw it come down in Q4, and we’re watching to come down here to date in Q1, and we’re seeing it be in a good spot by the end of the quarter. And then I think your second part was about the $300 million, effectively undershipping the market in 2023. That was the estimate we gave at our Investor Day. That number is actually holding as we finish the year. So that’s what we undershipped the market in 2023 for home standby. Now obviously, we won’t get all that back in 2024 as a tailwind, given that Q1, we’re still working things down here. But you’ll get a chunk of that as a tailwind to growth. And again, we talked about that, I think, on the first question.

Operator: Our next question – next question comes from Brian Drab with William Blair. Your line is open.

Brian Drab: Hey, good morning. Thanks for taking my questions. I was wondering if you could…

Aaron Jagdfeld: Good morning, Brian.

Brian Drab: Good morning. Can you give any more color or quantification around what’s happening with the IHCs year-over-year sequentially?

Aaron Jagdfeld: Yeah, sure, Brian. So a couple of things. We saw IHCs actually soften in Q4, and that really largely aligns with the power outage environment was well-below the baseline average. So in fact, it was the lowest Q4. I think in our prepared remarks, we said since 2015. So pretty low environment for outages. And that fit with a good chunk of the second half, right? We didn’t see a lot of activity, certainly no major activity in throughout the year last year. But in spite of that, IHCs were up on the year, total count so in spite of the softness in the fourth quarter. And probably more importantly, January, we got off to a pretty hot start. There was quite a bit of weather localized, quite a bit of outage activity.

And then more importantly, I think one thing that we are starting to see, which is really interesting in the category, normally, the category has traded on outage activity. But what we’re also seeing is evidence now in markets where outages haven’t taken place but where media reports and other information is flowing into the market around potential outages, right? So these notifications of power shortfalls that some utilities had to send out in January, because of the extreme cold weather that actually drove IHC activity. Without actually having — it didn’t really result in a trendous amount of outage activity, but it drove IHC activity. So it’s kind of — I don’t want to say there’s a disconnect now, but looking purely at outage activity is probably not the only way to look at IHC, which are — that’s our proxy for sales leads.

I would just — one other kernel to this. We also continue to see a modest improvement in close rates in the fourth quarter for IHC. So we’ve talked about this recovery story on close rates. We kind of had assumed that close rates were going to flatten out after Q2 last year. And we saw that initially, but then we’ve actually started to see some of those close rates improve. And that’s encouraging because I think it speaks to the continued not only interest in the product, but obviously, the conversion of prospects into buyers. So I think those are encouraging signs. There are green shoots, if you will, and lead us to have, I think, gives us anyway confidence in certainly gives us confidence in the guide that we gave this morning around the consumer power products.

Operator: One moment for our next question. Our next question comes from Christopher Glynn with Oppenheimer & Co. Your line is open.

Christopher Glynn: Thanks guys. Grant me a clarification before my question. Did you say 45%, 55% first half, second half split for sales?

Aaron Jagdfeld: Yes, that’s correct.

Christopher Glynn: Okay. Great. For curious what you have baked in for close rates following up on that topic. And last quarter, you mentioned October saw a nice bump. Did October account for all of the 4Q improvement? Or was each month at October better than the quarters that preceded it? I mean, each month in the fourth quarter?

Aaron Jagdfeld: Yeah. Thanks, Chris. I don’t have the pacing each month for the quarter, to be honest. I just all add — you’re correct, we did say on the Q3 call that October, we saw some improvement. It was — it’s pretty — it was modest, but we like that it was improving, not going the other way. For the quarter, it was up again modestly. So I think you can assume that it was — it didn’t drop off because that would have set us negative for the quarter. So again, I don’t have the pacing, apologize for each month of the quarter. But the assumption to your question, the assumption for 2024, we are assuming close rates kind of continue on that modest improvement pace. We’ve got a long way to go to get back to the kind of pre-pandemic or that kind of pandemic-induced high, if you will.

We kind of hit that. I think the peak, Chris, was, we say, Q3 of 2020 is where we kind of peaked out. And then we saw things really fall off as our lead times extended and now we’ve been in that recovery mode. The good news is, we’re seeing that recovery. I do think kind of pursuant to my answer to the previous question, about — or the additional color from the previous question about we’ve got more people coming into the sales funnel that maybe aren’t experiencing outages, but they’re concerned about outages and they’re hearing more about it. Either because of media reports or other things or maybe notifications from their local utility that they could be at risk of an outage with cold temperatures if there — if they don’t immediately turn off or reduce their power consumption.

Those are scary things. When you’re a homeowner and you get that text message, and it’s zero degrees outside, you need to reduce your energy consumption immediately or you could be facing blackouts. I mean that’s — those things send people on a hunt for solutions. And that’s when we see and we are seeing evidence that people are coming into the sales funnel. I will say that, it’s going to be a longer conversion cycle for those homeowners if they haven’t experienced an outage. So we’re aware of that. And we think that, that could lead to some — could take a little bit longer than for close rates to really truly recover to that level as a result of just more people coming into the sales funnel and investigating the category. We don’t necessarily think that’s a bad thing.

We just think that it means that it’s even more important that our nurturing efforts and our efforts to continue to engage homeowners who have interest in the product category that we remain very diligent in our efforts there. So again, close rates, the assumption, kind of a modest improvement over the course of 2024.

Operator: Our next question comes from Jerry Revich with Goldman Sachs. Your line is open.

Jerry Revich: Yes. Hi. Good morning, everyone. Arne, can you just talk about the margin outlook. So you had 20% margins in the fourth quarter. And seasonally, that’s a 19% annual equivalent rate and we’re looking at guidance of 17%. So what’s the 200 basis point margin degradation beyond normal seasonality that you folks are guiding to R&D or other areas? Can you just expand on the drivers compared to the — ?

York Ragen: Yeah, in the prepared — I did talk about our operating expense investments. So we are expecting those as a percentage of sales to go up as we as we add the resources necessary to continue to drive our growth. At our Investor Day, last September, we talked about a lot of significant long-term growth opportunities. We want to add those resources here in 2024 to go after those opportunities. So that — you had that before the revenue is incurred, and that’s really across all of our business, not just — it’s — it’s our consumer power business, our industrial business, our Energy Technologies products. And you need to add those costs before the revenue and that will increase our OpEx as a percentage of sales, we believe in 2024 relative to 2023. And maybe that’s probably the — just to square that up with maybe the math that you’re looking at.

Aaron Jagdfeld: Yes. I think, Jerry, just — just one last comment on that. We have been investing heavily for the future here. We think those investments are both necessary and I think improve our odds of being successful as the market continues to change. There is just a ream of evidence around the fact that the grid is changing. I talked about it in my prepared remarks. We talked to a lot of utility and grid operators. They are — there is a significant challenge ahead, as we continue to retire traditional thermal assets on the supply side in favor of renewables, which is — I think we all agree, we want to decarbonize the grid as much as we can. The challenge, of course, is those renewables are intermittent in nature. And storage costs are still high.

And large-format utility storage is difficult to balance out with the cost of building those renewable plants. You couple that with this — what we’re now seeing, which is an increase on the demand side, which we haven’t seen in decades. The demand side has been relatively muted. Retail electric sales have been relatively muted over the last couple of decades as maybe some of the growth has been offset, some of the either population growth or just growth in some of the power usage devices has been offset by efficiency gains, but that’s changing. And we’re seeing the electrification trends again, around cooking around cleaning around heating and cooling, certainly around transportation, super early innings there. But it’s creating these incredible opportunities for mismatch of supply and demand.

And in particular, as more severe weather and volatile weather patterns pick up, that is putting dramatic stress on the grid. And so I don’t — again, we couldn’t be in a better place at a better time with the products and solutions that we’ve assembled here. We have a lot of work to do, obviously, to deploy those to great effect, to build out these ecosystems for homeowners and business owners. We’re working very hard on that. And the work is the investment level we’re talking about here, and that is what York was referring to, certainly in the — throughout the year, 350 to 400 basis points dilution to EBITDA margin.

York Ragen: For Energy Technologies.

Aaron Jagdfeld: For Energy Technologies.

York Ragen: Having said all that, we start expecting to increase our EBITDA margins from 2023 to 2024.

Aaron Jagdfeld: Yes. Good point.

Operator: One moment for our next question. Our next question comes from Stephen Gengaro with Stifel. Your line is open.

Stephen Gengaro: Thanks. Good morning gentlemen.

Aaron Jagdfeld: Good morning.

Stephen Gengaro: So two things for me. The first — and I’m not sure if you’re able to comment, but when you talk about that margin drag from the new energy technology side, and you sort of painted this picture at your Analyst Day, but should we expect that to start to dissipate in 2025?

Aaron Jagdfeld: Yes, absolutely. And then the idea, as we laid out — and we’re still on our path here. But the idea, as we laid out in September at the Investor Day is that we would be at breakeven. We would start to achieve breakeven levels in that business in 2026. So you will start to see an abatement of that dilution impact. It’s just not going to happen this year. So it really starts in 2025 and it accelerates.

York Ragen: 2026 is what we would.

Aaron Jagdfeld: Cut in half by 2026, right? Exactly.

Operator: One moment for our next question. The next question comes from Mark Strouse with JPMorgan. Your line is open.

Mark Strouse: Yes. Good morning. Thanks very much for taking our questions. I wanted to start with the gross margin guide for 2024, 37%. That would be the highest since 2020. I assume a good part of that is driven by mix. Can you talk about your expectations for pricing that are embedded in that? And then just a quick clarification question, if I could. Residential revenue in 4Q grew 1%. I think you said that home standby grew maybe upwards of 10% and the Energy Tech business grew as well. If that’s true, what was the offset to get to 1% growth?

Aaron Jagdfeld: Yes. So, let me unpack that. So it was mostly portable gens in Q4, again, with a really soft power outage environment and no major events.

York Ragen: And a tough comp last year.

Aaron Jagdfeld: And a tough comp last year.

York Ragen: Here and in Europe.

Aaron Jagdfeld: Correct. Yes. And the European side of that as well, to York’s point, the Russia-Ukraine war, they just they haven’t really — some of the energy concerns, security concerns haven’t come to a pass there. And as a result, we saw — we’ve seen portable gens really come off and also tour products were soft. We said — we called this out throughout the year last year, we had a tough year with our tour products business. So, that was also soft. But that was offset by 10% growth in HSP and some growth also in the clean energy business. On the margin question, I’ll just — I’ll touch on the price piece of that real quick, and then York can kind of round out the discussion. But it’s small. I mean we got a little bit of price in there this year, just to cover some of the additional costs that we’ve seen around the investments that we’ve had to make as we scale the business, but they were quite modest, I would say, in terms of price.

There’s no big price. So the rest of it–

York Ragen: I’d say half of that gross margin increase that you referred to is, in fact, mix, obviously, as resi and home standby grow faster than our C&I business, that will be a tailwind to gross margin growth. The other half is really cost continuing to abate the realization of the cost that we’re experiencing were, I’d say, in the beginning of 2023, we were still feeling the supply chain pressures that spilled over from 2022 into 2023, those are largely — we won’t see that in 2024 here. Logistics costs, I think we were as those costs build over from 2022 into our inventory as we sell through that inventory, that headwind that won’t be a headwind. As we ramp up our production in our plants, we’ll have obviously favorable overhead absorption, lower warehousing and storage costs as we bring our inventory levels down, that’s sort of behind the scenes, there’s a lot of — we don’t need as much warehousing space to store the inventory anymore.

So, that builder costs will come down. Just general plant efficiencies. And then we always have our profitability enhancement program that is — it’s sort of part of our DNA now that we cascade cost reduction initiatives across the company throughout the company. And we have goals for those initiatives and projects that we believe we’ll realize in the second half of the year. So, the cost side of it is an important side of it as well in terms of the gross margin improvement.

Operator: Our next question comes from Donovan Schafer with Northland Capital Markets. Your line is open.

Donovan Schafer: Hey guys. Thanks for taking the questions. So, I want to ask for some of the softness on the C&I side of the business. In the release, you mentioned it also applies — of course, there’s telecom and the rental accounts is kind of what comes first in the order of significance, it seems like. But the beyond has become increasingly interesting. And I believe in chance at rock has been an important part of that. I believe it goes into that bucket. Correct me if I’m wrong on that. And so I’m curious if you can comment on what you’re seeing in the beyond standby and kind of the weakness there? If it is tied to enchanted rock kind of when that agreement ends? I believe it was either expiring this in 2023 or 2024. If you expect that to be renewed, and if you can comment at all on potential for data center demand being helpful.

I know you have — I believe you have the largest natural gas generator for data center back up. So any color on those would be appreciated. Thank you.

Aaron Jagdfeld: Yes. Thanks, Donovan. So yes, I think it would be good to maybe spend a few minutes on the C&I side. We — that business has been on an absolute tear over the last three years, CAGR close to 30%. It’s a $1.5 billion asset for us today globally. It is a truly global business. And in fact, we have a lot of long-term conviction there. As evidenced by we broke ground on a new plant here in Wisconsin just here in the fourth quarter because we see the long-term need for additional capacity as the market grows. Specifically, we have always seen certain cycles in the C&I markets. We’ve been serving the — I’ll start with telecom kind of work my way through the walk here on kind of the three different areas we called out specifically in the prepared remarks.

But I’ll start with telecom. It’s been an important vertical for us. Historically, around 10% of C&I. We had a really strong year — a really strong year in 2022, with telecom, we started to see that soften up in the back half of this year. We called that earlier this year. So it kind of fell in line with what we saw. But I think we were more hopeful that it would rebound more quickly here in 2024, and right now, all evidence based on kind of — you can look at any of the transcripts for many of the major wireless carriers. We’re a Tier 1 supplier to all of them. They’ve all kind of cut their CapEx guide year-over-year by roughly 10%, call it. So I think that’s kind of a proxy for what we’re seeing to some degree in telecom. But we’ve seen this movie before.

We’ve been serving that market for 40 years. And they tend to cycle on and off of CapEx. Some of it is the pacing of the build-out of the network. Some of it is they’re balancing other capital priorities, sometimes M&A, sometimes other things. So we’ve seen that before. That will come back, absolutely. And we feel like that’s just a cycle we’re going to get through here in 2024. The other one is the rental accounts, the national rental accounts in particular. Again, we’re a major supplier to all of them. And you’ve seen a couple of the rental customers come out, rental accounts come out and say that their CapEx is going to be lower year-over-year. So we’re kind of — we’re kind of working off of that, those types of guidances. And in particular, there’s been a pretty heavy refleeting cycle over the last few years in the categories that we supply, in particular, in Power & Light.

So where you’ve got temporary power or temporary lighting, those are the products we manufacture and put into those channels. They’ve gone through a heavy refi leading cycle. And now they’ve got to wait for the utilization rates to kind of get to where they need them to be before they start kind of purchasing new equipment. So again, we’ve seen that cycle about three times in our ownership and our participation in that market over the last decade plus years. So that’s just cycle. And then the last one is beyond standby. That is an area that’s been very interesting. It’s grown very quickly. We have customers like in channel rock [ph] in there. They’re not the only ones. We’ve got others that we sell a lot of these generators and in particular, on the gas side, where we would sell a typical gas generator for emergency backup, customers are finding that there’s additional utility and value that they can deploy that generator in perhaps a grid support type program, right?

So time of use program or some other kind of demand response type program, and they can help monetize the asset in a way that they couldn’t before. They had to think of it purely as a kind of a — it was really a disaster response type purchase before, kind of an insurance policy. And so not something that would necessarily create a return year after year, right? I mean it obviously would give you a return, if you experience an outage, that’s infrequent use. This is a way now to — as natural gas prices have stayed low, electricity prices continue to rise, that has been a very interesting growth opportunity. I still relatively small in the context of everything we do, but it’s been growing very quickly, and we’ve called it out over the last couple of years.

Underpinned by Generac as an important customer there. But also data centers, these are smaller gas gens, so they’re used more in edge data centers, not necessarily hyperscale. Hyperscale data centers are still going to be using very large diesel gens that are manufactured by our competitors. We’re not in that business today. So we’re really serving more of the edge data center markets or those data center operators that want to use those assets in a monetized fashion. You wouldn’t be able to do that economically with diesel. You can do it economically with gas, but it takes a lot more gens to get to the same level of protection, because the density, the power density of each generator for gas is lower than it is for diesel. That’s just a — that’s a physics thing.

You can’t get around that. But that’s — it’s still a great market opportunity. We just — what we called out this morning in the prepared remarks there, is with a higher interest rate environment, we’re just seeing those projects get pushed out the time lines, right? So we think it’s temporary. We think it will return when interest rates kind of return to a more normal level. Do we know when that is? No. I think you listened to economists and we see a lot of them and hear a lot of them, it’s anywhere between zero rate cuts and 12 this year. I don’t know. Take your — pick your number, but we’re watching that. We’re seeing kind of what goes on in that environment, but we do think that as rates come down, that obviously changes, I think, the — not only the economics around those projects, but shouldn’t bring some of those projects that have been delayed back into the mix.

Operator: One moment for our next question. Our next question comes from Kashy Harrison with Piper Sandler. Your line is open.

Kashy Harrison: Hi. Good morning, all, and thanks for taking the question. So maybe just sticking with C&I since we’re talking about it. Aaron, as you pointed out, you guys have been serving telecom for, I think, you said 40 years and rental companies for a really long time. So how long does it typically take for the spending to recover on average? Is this something where it drops and stays down for a year, two years, three years? Just maybe help us think about that. And then similarly, following up on this topic of interest rates, can you walk us through the level of rates that drove weakness in that segment? Was it when we got the 5% on the benchmark. Was it another level — just trying to think — and just trying to think through if we get to 3%, is that when the segment is back? Is it 4% is at 2%? Just some thought around the level of rates and how it impacts the beyond standby business. Thank you.

Aaron Jagdfeld: Yes. Thanks, Kash. So with respect to the telecon rental cycles, just kind of how we’ve seen that historically, they play out in like four to six quarters generally is kind of how it plays out. There can be unique situation we had, as an example, when consolidation has happened historically in the telecom industry, an acquisition of Sprint by T-Mobile, that kind of thing or merger, those types of situations. Those can be more unique. Those — whenever there’s major acquisitions, that usually creates a pause in CapEx as the carriers do their integration activities, and they try and rationalize what they’ve acquired in terms of the assets and the networks and how they want to deploy that going forward from a strategy standpoint.

But typically, four to six quarters. And similarly, on the rental side, those refleeting cycles can be a year or two, depending on the category, depending on the customer, depending on the market. Sometimes they’re influenced in oil and gas, as oil and gas prices go up, that can mean better utilization of the equipment in certain regions, where they’re used in those applications. And so the timing can vary, but I would say pretty reliably. Historically, we’ve seen four to six quarters. The beyond standby — sorry.

York Ragen: I’m going to say because we sell direct, you tend to see it quickly too. Like do they turn it, they can turn it off fast or if they can turn it on fast.

Aaron Jagdfeld: Really good point. Yes, we tend to see them while their capital spending, their purchase orders can be, as York said, it can be pretty abrupt both on and off. So we watch that very closely. One of the reasons, we’re expanding capacity in C&I, the range of product, we’re aimed at actually is what we would refer to as our midrange product, which really goes after that telecom market and some of that temporary power market for the rental markets as well. It’s kind of the mid-range products. And that’s where we see — we are absolutely the strongest manufacturer there in North America in terms of our share and our aggressive stance with these customers. We have an outsized share with these segments, which is maybe why we’re getting hurt a little bit more than perhaps some of our competitors in some of the — in C&I in 2024.

Some of our competitors are a little more focused on the hyperscale data centers. As I said before, we don’t have products there. So I think some of the way we’re looking at the markets in 2024, maybe differ from some of our competitors as a result. To answer your question on kind of what interest rate level kind of impacts the beyond standby market, we kind of saw projects starting to kind of elongate in the cycle. It’s new to us. So we haven’t been through a rate a higher rate environment there with that product category, so it’s new. So we’ve got a lot of learning cycles there. We’re trying to get under our belt. So I can’t give you an exact rate, because the one thing we do know is that every project pencils out differently in every market.

It really depends on the local utility costs in the market. It depends on the use case of the products in a particular market, the end customer, the project size, there are just a ton of factors. So I would tell you that I don’t know that there’s like a specific interest rate level where we could say, we called it being cooling off and vice versa, a specific interest rate level where we would say, if we get to 3.5% that it will turn back on. I think a lot of that’s just going to depend on economics improving in particular markets, and there’s just a ton of factors that go into each one.

Operator: One moment for our question. Our next question comes from Joseph Osha with Guggenheim. Your line is open.

Joseph Osha: Thanks for taking my question. I have two product questions for you. The first one relates to some of the DC generators that you were talking about as products to be coupled with storage. I’m curious if we can get an update there. And second, in terms of the storage strategy, given the time line you’re talking about in the micros, I know you still have the pipe architecture out there. What can you tell us in particular about how you — what your outlook is for AC couple storage and whether we might see you selling storage alongside other people’s inverters at some point during 2024 as we wait for the updated silicon product to come? Thank you.

Aaron Jagdfeld: Yes. Thanks, Joe. Good questions, all of those. I think — so on the DC generator question, that was a very small product that we launched a couple of years ago. We didn’t see a ton of receptivity to it. It really was aimed at people who truly wanted to be unplugged from the grid, be isolated, independent from the grid. And it’s a small host of customers. What we actually think is probably a better opportunity going forward is to take our existing AC product, AC generator products in an AC-coupled environment and allow the generator to act as a as a battery charger through an AC coupling as opposed to a DC. So, it’s just — it’s a little bit — it’s not quite as efficient, but it allows us to leverage the AC generator platform, which in terms of our cost structure, is, frankly, just — it’s just better because we just — we have scale there, we can offer better value to customers, even though we might be taking away a little bit of value in terms of the AC generators are a little bit louder.

They maybe use a little — consume a little more fuel, but not materially. So, that kind of direction we’re headed strategically there is kind of moving away from the DC generator product to the AC generators, but it’s a really small part of our product line. The broader question, and you’re asking kind of an AC coupling, we have AC coupling capabilities today with the Pika system. We can take the battery as a stand-alone with the Pika inverter, we can AC couple it to competitors’ inverters. That’s not the most efficient architecture, so as we introduce new products later this year, the next-generation storage products, we’re going to improve the capability for AC coupling and make that a more, I’ll call it, a better experience, a more sophisticated experience, a lower cost experience going forward.

And then of course, that sets us up nicely as we go forward with the microinverter products into 2025. And we’re going to continue to offer the Pika products. I mean there are — if you’re doing a clean sheet implementation, we still believe that DC coupling is the most efficient — round trip efficient way to do that. And so we think there’s a place in the architecture for that system, at least for now. But as we roll micro-inverters out and as we continue to build out our strategy and have success, I think the market will tell us directionally where we need to go. I think you, in particular, pointed out trying to support both architectures going forward is a heavy load to do, and we would probably tend to agree with you on that. But again, we’ve got a long way to go before we’re kind of proficient in the AC coupled solutions with the micro inverter solutions.

There’s some very capable products in market today, and it’s taken us a long time to get to market because we are going to have a product that we’re proud to put our name on, and that will stand the test of time from a reliability standpoint for our customers. And we’re working through that. It’s part of the big investment that we’ve been talking about, this 350 to 400 basis point drag. It’s a piece of that on EBITDA margins, but we’re committed to it. We think that there’s a huge opportunity for us to be successful in that going forward.

Operator: Our next question comes from Jordan Levy with Truist Securities. Your line is open.

Unidentified Analyst: [indiscernible] on for Jordan. Thanks for taking my question. As it relates to the dealer count, I think you closed the year with 8,700 and we have talked about the desire to bring that number closer to 10,000 over the coming years. So, can you maybe talk to the work you’re doing there and some of the sticking points that makes it more challenging to bring that number up? Thank you.

Aaron Jagdfeld: Yes, absolutely. Great question. And we’ve had some eye-popping increases over the last couple of years in dealer counts. 2023 was a more muted year, right? We kind of flatlined in 2023. Part of that is, I think, the large increase that we saw a little over 2,000 dealers being added in the years leading up to 23%, you’ve got, I think, as you would imagine, you’ve got a process there that we — our dealer count, by the way, is on a net basis, right? So — and we basically — we don’t count a dealer for the purposes of that account if they haven’t bought anything from us in a 12-month period. So we’re maybe a little bit hard on ourselves in the way we think about dealer counts and the way we talk about it. If you were to actually look at the total number of dealers in our network, it’s more than 8,700.

But the 10,000 is a target on a net basis and we are still targeting that. The headwinds to that this year, in particular, where I think just the kind of rollover of some of the ads that we had, we still had a lot of really nice gross adds to the dealer count. So we’re bringing new dealers in — but we — as we call them, we call them dark doors. When a dealer hasn’t bought from us in 12 months, we put them in that dark door category, and that is an offset to any gross adds that we have. So it’s kind of churn, if you will. There’s a churn that happens there. We had more churn in 2023, churn of a lot of those dealers that were added over the last couple of years. That also happens when you have kind of softer power outage environments, which certainly, as we talked about Q4 being a softer environment, that’s a headwind to adding dealers, it’s tough to get people interested in the category if the demand isn’t there necessarily, right?

So we saw in-home consultations drop-off in Q4. So those things present headwinds. I think longer-term, as we’ve looked at this, we built this from basically zero, 20 years ago to 8,700 today to get to that 10,000, we’re deploying an army of people that are going out there and engaging with primarily electrical contractors, but we’ve started to open the aperture on that to also include HVAC contractors. One interesting trend that I think many people have probably noted is you’re seeing kind of a consolidation of kind of home services businesses. So electrical contractors getting into the HVAC business or vice versa or into plumbing or into home automation. Kind of this broadening of the suite of services that a contracting business will offer.

It’s giving us a nice opportunity to get introduced to new kind of cohorts in the contracting business. And then on top of that, I would tell you that bringing Ecobee into the fold, they have upwards of 14,000 HVAC contracting relationships just with the 3.5 million homes that they put devices into and that is kind of a really important kind of feeding ground for us in terms of a bench, if you want to think of it that way, where we can add and bring new dealers in to sell to. So working all of those pads, I’m very confident we’re going to get to 10,000 as the category continues to expand in the years ahead. So we haven’t kind of put a pin on the date that’s going to happen, but it’s definitely going to happen as the category continues to grow.

Operator: One moment for our next question. Our next question comes from Chip Moore with ROTH MKM. Your line is open.

Chip Moore: Hi. Thanks for taking the question. I wanted to go back to visibility for C&I with some of that cyclical deterioration you’ve seen since the Investor Day. Aaron, is there maybe a potential for infrastructure investments to kick in here at some point and start to help drive growth there? And then any implications for those three-year growth targets you’ve laid out? Thanks.

Aaron Jagdfeld: Yes, it’s a great question. I think in terms of infrastructure, obviously, anything that moves the needle there will certainly help shorten the cycle, kind of off cycle for the rental equipment for sure. The telecom cycle, I think, is going to play out. Some of that is it’s kind of the installation bandwidth that those network kind of operators have to build out, like the speed at which they can build out their networks. There is some — we ran into some headwinds there with some specific customers just being able to kind of keep pace with installations according to their schedules that they had originally set for themselves. We were giving them product according to the schedules. You could probably say, okay, maybe there’s some field inventory there as a result.

We’re not really calling it that way because it’s not really a business we talk about inventory being carried for, but that’s somewhat the issue there with maybe one or two of those customers, but I think that cycle — I don’t know if there’s much we can do or that we would see to point to kind of that cycle accelerating. I think it’s just going to have to play out the way that it plays out. But I think, again, the C&I cycles we’ve seen this movie before. So it doesn’t really worry us. The visibility question is a good one. We — unfortunately, because these are big customers that kind of in our world, they wheel big pencils, right? They’ve got — that’s probably a dated term now, but they can write big, big people. They can write big POs or they can stop writing big POs and we get forecasts from them and we listen to the same things that others listen to in terms of their CapEx guidance because that obviously is the best proxy that we can use and we have as much dialogue with them as we can about what are their build-out plans for networks and what are their build-out plans for fleet when it comes to the rental customers.

And we know, we have some visibility in the pipeline for beyond standby projects as we’re quoting them. But unfortunately, visibility, it’s probably the weakest area of visibility for us in terms of our C&I business. When you look at the strength we called out in C&I which is offsetting some of this weakness and won’t offset all of it, obviously, because we’re saying C&I is going to be down for the year 10%. But offsetting that, our — we call it our IDC, our independent distribution network is we continue to see growth there. In fact, in some of the distribution partners, we actually have acquired a number of them over the last several years. And that’s given us really clear insight and really good visibility actually into some local markets.

And that is much more of a quotation business. And so we have, I think, much better visibility in that part of the business on C&I, but not as much, unfortunately, in some of these national account customers that can be I think, a lot more volatile in their order patterns.

York Ragen: And there are some pockets around the globe that we’re seeing growth as well the offset some of that softness. But I think the last part of your question was, how do we feel about C&I in the LRP that we — the long-range plan that we rolled out during Investor Day. And I think — in talking to the team that runs that business, it’s — I think because they these select certain customers that we’re referring to in telecom rental beyond standby maybe they turned things off a little bit harder than we were expecting when we were walking through the Investor Day materials, but we think they think we think that they can turn them back on just as fast. So…

Aaron Jagdfeld: They have put a cycle in the LRP exactly.

York Ragen: But maybe it just was a little bit harder down in ’24 than maybe the rig thought. But they think they’re going to be turning things back on in line with the LRP in ’25, ’26, call it.

Operator: One moment for our next question. Our next question comes from Keith Housum with Northcoast Research. Your line is open.

Keith Housum: Good morning, guys. Thanks for getting me in here. Just one question in terms of the interest rates. This time, focus more on the HSPs. Can you guys remind me in terms of how critical is the interest rate environment to, I guess, the growth or decline of HSPs in any given quarter?

Aaron Jagdfeld: Yes. Thanks, Keith. And sorry to get you in here at the end. I made you wait, 1.5 hours. But yes, the interest rate, actually, we’ve said this a couple of times, I think as we talk through this, I don’t know if we’ve talked about it publicly as much, but it’s not a high — the home standby category, in particular, is not a highly interest rate-sensitive category specifically. Now obviously, the impacts, the higher rates have on the macroeconomic environment be the job security issues for people or kind of other challenges with maybe around the way they feel about the way people feel about spending money on large ticket purchases that does have an impact kind of on the margins, but…

York Ragen: It’s not a highly financed.

Aaron Jagdfeld: It’s not a highly financed purchase, oddly enough. Now that said, we do have a third-party financing program through Synchrony, which has been a great program. It grew like almost 50% last year. So we are seeing more evidence of people using finance. But then when you peel the onion back, the number one thing that we see people using is the 18-month same as cash. So — we don’t think that — we think that that’s not necessarily evidence they’re just deferring their payment

York Ragen: So the cost was…

Aaron Jagdfeld: That doesn’t cost me I think they’re going to use somebody else’s money for that 1.5 years. So I don’t think that all indications are that — and you look at the kind of demographic that we sell into primarily there. And these are people that are — there are older Americans who — they have got their home paid for in a lot of cases, they’re probably retired in cases. So for them, it’s more about the — protecting their home, protecting their safety protecting their families. And I think that it’s — frankly, it’s more about that than it is maybe about where interest rates are at any point in time.

Operator: That concludes the question-and-answer session. At this time, I would like to turn the call back to Kris Rosemann for closing remarks.

Kris Rosemann: We want to thank everyone for joining us this morning. We look forward to discussing our first quarter 2024 earnings results with you in early May. Thank you again, and goodbye.

Operator: Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.